Luke Baker
Economic experts watching Spain do not know how much money will be needed or precisely when, but some are near certain that Madrid will eventually seek a bailout for its banks, and perhaps even for the state itself.
Prime Minister Mariano Rajoy has repeatedly said Spain did not need or want an international bailout, and the EU, which along with the International Monetary Fund has already rescued Greece, Ireland and Portugal, also dismisses such talk.
But economists believe Spanish banks will have to turn to the euro zone’s rescue fund, the European Financial Stability Facility (EFSF), for help in covering losses caused by a crashing property market.
Likewise, investors are fretting about how Rajoy’s centre-right government can enforce deep austerity while reviving a recession-bound economy at the same time.
“They’re going to need EFSF money to recapitalise the banking sector,” said Carsten Brzeski, a senior economist at ING in Brussels. “I think we’ll only see a real end to the Spanish misery if the real estate market stabilises.”
“The underlying picture in Spain is dramatic, but is it dramatic in the way that it needs a bailout package tomorrow? No,” Brzeski said. “But if you look ahead, let’s say the next six months, I would not be surprised if they (the banks) have to get some kind of European support.”
Market concerns about the euro zone’s fourth-largest economy have deepened in the past week. Yields on the government’s 10-year bonds, which reflect the risk investors attach to owning Spanish debt, have risen above 6 percent, a level that has proved a trigger point for other troubled euro zone countries.
EU backing
At the moment the EU is backing Madrid. Luxembourg’s Jean-Claude Juncker, who chairs the Eurogroup of euro zone finance ministers, said Spain was taking the necessary steps to get its economy back on track, despite a recession and unemployment at 24 percent.
“I don’t think Spain will need any kind of external support,” Juncker said. “Spain is on track.”
German Finance Minister Wolfgang Schäeuble also rejected comparisons with countries that were already on bailout programmes. “The fundamental data in Spain is not comparable to those in the countries that are under a programme,” he told Reuters. “Spain needs to work to win confidence, however, if the positive developments are to continue.”
Markets took fright earlier in the year when Rajoy relaxed his government’s targets for cutting the budget deficit.
However, not all economists are so pessimistic and some say the four-month-old government is starting to knuckle down to meet the new targets, which still demand deeply unpopular austerity, and tackle the economy’s structural problems.
“We’ve seen more progress in a few days than in four months,” Deutsche Bank economist Gilles Moec said. “It’s a country that’s intrinsically sustainable, but it… needs to make decisions.”
Others disagree and fear Spain will drag in Italy, which has also suffered rising borrowing costs.
“As I look at my screen and Spain’s 10-year yields are up at 6 percent – things are starting to get worrying again,” said Peter Westaway, the chief economist for Europe at investment management firm Vanguard.
“If they go up to 6.5 percent to 7 percent, that could become very problematic, and if Italy started to go back above Spain again, then that would be really serious.”
Spain has one thing on its side. It has already raised nearly half the e86 billion (R889bn) it needs to borrow from financial markets this year, sucking up some of the e1 trillion of cheap loans the European Central Bank has pumped into the euro zone banking sector.
This means the government could hang on for months before having to turn to the EU for help with its own funding needs.
e380bn overhang
However, that still leaves the banks. One of the critical “unknowables” for Spain is just how bad a situation its banks are in. The Spanish housing market has been in turmoil for more than four years, but prices still have not fallen as much as economists think is needed to squeeze the air out of the bubble.
Only when prices bottom out will assessors be able to calculate how just much bad mortgage debt is sitting on the banks’ balance sheets and how much capital the sector needs to return it to health.
“Prices have dropped by about 15 percent to 20 percent from peak to now and they will probably have to drop another 15 percent to 20 percent before they reach bottom,” Brzeski said. He estimated Spanish banks might need as much as e80bn of extra capital once all bad mortgage debt was accounted for.
In a paper published this week, Daniel Gros and Cinzia Alcidi of the Centre for European Policy Studies estimated that the total accumulated overhang in the Spanish property and construction sector was more than e380bn – 37 percent of gross domestic product (GDP).
“A housing overhang as such does not have to lead to an acute financial crisis if it was financed by domestic savings,” they write. “Unfortunately this is not the case in Spain.”
As a result, economists expect Spain’s banking sector will have no choice but to recapitalise. The government is unlikely to fund such an operation while it is trying to slash the budget deficit, and private investors are reluctant to invest in such a troubled sector.
That leaves the EFSF as the most likely option for the banks.
“The banking sector is only one piece of the puzzle in Spain,” Roubini Global Economics senior economist Megan Greene said. “A banking bailout could deal with one part of the problem, but eventually the sovereign is going to need a bailout too.”
Then the problem will be what to do about Italy, with GDP 50 percent larger than Spain’s. – Reuters